A Twist of Fate

Mike Hofman was previously editor of Inc.com and a deputy editor at Inc. magazine, which he joined in 1996. The site was nominated for a National Magazine Award for Digital Media in 2010, and was named the best business website by Folio Magazine. In 2006, Hofman was part of a team of writers nominated for a Webby Award for best business blog. He lives in New York City.

Movie producer John Davis wanted a healthful snack. The founders of Wetzel's Pretzels wanted cash. Of all the pretzel joints in all the towns in all the world, he walked into theirs.

John Davis is a player, a green-lighter of gargantuan film budgets, a scion of Hollywood royalty. The proud producer of such movies as The Firm and Doctor Dolittle, Davis has worked with Hollywood's A-list: Tom Cruise, Meg Ryan, Denzel Washington. Even his Los Angeles office is a Tinseltown landmark, located in the gleaming glass tower that Bruce Willis saved from Euro-trash terrorists in Die Hard. The surrounding neighborhood—erected on what was formerly a studio back lot in Century City—is awash with famous tenants. ABC, Bear Stearns, and SunAmerica have offices there. So does Warren Christopher, the former secretary of state.

But despite its affluent workforce, Century City is short on fine dining. So when the pangs of hunger interrupt Davis's wheeling and dealing, he usually heads next door to the Century City Shopping Center. On one such excursion in 1996, a woman proffering a tray of plump, warm pretzel pieces accosted him. Davis sampled one—and became a devotee of Wetzel's Pretzels and a regular patron of that outlet. "A hot, fresh pretzel is my favorite kind of treat," Davis says. "I like things that are healthy and not that fattening. I'd rather have a pretzel than a Krispy Kreme doughnut any day."

Over time Davis's hunger turned into curiosity. "I wondered who owned this company and if I could get a piece of it," he recalls. "It was the classic Warren Buffett-Peter Lynch thing of 'invest in what you know and love.' "

And thus, John Davis fell into the trap. It was a trap that had been set with care by Wetzel's founders, Rick Wetzel, 42, and Bill Phelps, 45, who had opened the Century City store partly in the hopes of bagging just such an investor. "It's no joke," says Phelps. "A lot of lawyers and entertainment people work in that area, and we chose that location in part because we thought we might happen across a financial investor." That putting-yourself-in-fame's-way strategy worked for Lana Turner when, as legend has it, she was discovered at Schwab's Pharmacy. That scheme has been almost as successful for Wetzel's Pretzels.

Not that the founders of Wetzel's, at the time of their discovery, were engaged in the business equivalent of lounging at the Schwab's soda fountain and dreaming of their big break. In 1996 the company—a franchise operation—was borderline profitable, although neither cofounder was drawing a salary. "We were plodding along on our own growth rate and cash flow," Rick Wetzel says. "We weren't actively looking for money, but we knew we needed a slug of cash to put the infrastructure together to find good franchisees and good sites."

Indeed, the company was at a crossroads. Wetzel and Phelps had opened the first Wetzel's Pretzels in Redondo Beach, Calif., in 1994, while both were brand managers at Nestlé. The two had met at the Swiss food conglomerate, and because they shared a contempt for bureaucracy, they began thinking about starting a food company themselves. Wetzel claims they chose the milieu of pretzels not because of the obvious rhyming opportunity but because they thought the existing competition -- Auntie Anne's and two small outfits owned by Mrs. Fields Cookies—was, well, soft. A Nestlé chef helped them devise a recipe, and the two partners put up $200,000 from their savings to seed the company.

The early Wetzel's stores were retail nightmares, the founders concede. Inspired by the spartan appeal of the name Starbucks, the pair designed signs that bore the single word Wetzel's, which baffled consumers. Those curious enough to try peering inside were thwarted by shelves of precious little mustard jars that had been built into the stores' windows. And those who did enter the pretzel store were beguiled by its wooden paneling, plush booths, artsy black-and-white photographs, and sophisticated lighting fixtures—an elegant look on which the partners had spent a fortune. Gaggles of young patrons regularly congregated in these pseudocoffeehouses. Most passersby, seeing the crowds and misinterpreting them as long lines, lived up to their name.

By 1997 the founders had fixed some of those problems by eliminating seating in their new stores and moving counters close to the door. The mustard jars were gone, replaced by what Wetzel calls a "theater of rolling," where customers could watch workers preparing the pretzels. But the partners still wanted to hire an expensive design firm to create a new look for the outlets, and they also yearned to bring on an ad agency that would be worth its salt. In addition, their management team had big gaps in areas such as real estate, marketing, and operations, and those needed filling. It was at just that point that a charismatic young producer strolled into their lives.

John Davis is one of five children of Marvin and Barbara Davis, a legendary Hollywood power couple. Marvin Davis's fortune is estimated to be $3.5 billion; he has bought and sold such iconic businesses as the Resort at Pebble Beach, the Aspen Skiing Co., the Beverly Hills Hotel, and Twentieth Century Fox. Originally an oil baron from Denver, Davis père is said to have been the inspiration for the character Blake Carrington in the 1980s TV series Dynasty. Edging out from under his father's shadow, the younger Davis worked on the second Indiana Jones picture, earned an M.B.A. at Harvard, and then went on to produce 52 films that have grossed $2 billion worldwide. He also dabbled in angel investing, mostly notably in WebTV, which was acquired by Microsoft in 1997.

Davis's interest in Wetzel's Pretzels moved him to consult with Michael Seibert, his chief financial officer and a longtime family adviser. Seibert searched the Web and found a site that Wetzel's had set up to recruit franchisees. He called the number listed on the site, chatted with Phelps, and immediately saw a business opportunity.

Seibert liked the gross margin Wetzel's had: each pretzel cost 7¢ to make and sold for $1.59. He liked the product's positioning: tasty yet guilt-free. And he liked the customer demographics: 70% of customers were health-conscious women, according to in-store research. "It was a bit of an odd deal for us," Seibert says. "But occasionally we do things a little bit out of the ordinary."

Davis asked Phelps and Wetzel for a detailed new business plan to explain how they would use any additional money. After viewing that document, Davis personally called 11 acquaintances and persuaded them to go in with him on the deal. (The producer always works with coinvestors.) The coterie Davis assembled included Gary L. Wilson, chairman of Northwest Airlines; Dana Davis, his sister; Jake Bloom, a Hollywood lawyer; and David Israel, a producer of Monday Night Football. The group offered to buy 33% of Wetzel's Pretzels for $1 million. Davis also agreed to sit on the company's board, a position he ordinarily eschews for fear of being named in California's ubiquitous shareholder lawsuits.

After three months, during which everyone's attorneys vetted a two-inch-thick document, Seibert drove to Rick Wetzel's house late one summer afternoon in 1997 to drop off a dozen personal checks. The deal was closed.

The relationship between the founders of Wetzel's Pretzels and their powerful investors has not always been silky smooth. "When the money all comes in, you get this euphoric feeling that the bank account is full," Wetzel says. "All the things you ever wanted to do, you start doing them."

Newly flush, Wetzel and Phelps began by paying themselves salaries. Fair enough, said the backers. Next the founders hired five high-priced vice-presidents of finance, real estate, marketing, franchise development, and operations. Then they signed up with an advertising agency, which devised a colorful campaign for the company's new products, such as its Cookies 'N Kreme pretzels. They also retained a firm to redesign their stores. The bland wood paneling was stripped from the walls and replaced with vibrant mosaics and neon lighting.

But while the changes arrested consumers' attention, the mounting invoices arrested the attention of the company's backers. The losses at Wetzel's were growing and, worse still, deviating sharply from the projections in its business plan. "Our fixed overhead expenses went from $20,000 a month to $80,000 to $90,000 a month," Phelps says. "So we had a short honeymoon period followed by a losing-money-pissed-off period. We were hemorrhaging."

The chain has grown to 170 locations in 23 states and three other countries.

The investors demanded that the profligacy stop. Davis—perhaps made more empathetic by his experience of producing the famously expensive Kevin Costner dud Waterworld—was delicate in his criticism of Wetzel and Phelps. But others, especially Gary Wilson, were blunt about their displeasure with the numbers. "Being the former CFO of Disney and Marriott, I do ask financial questions," Wilson says. "And I kept asking those questions until they produced positive cash flow." The partners achieved that turnaround by paring monthly expenses back to $60,000, parting ways with their new vice-presidents of operations and marketing, changing the salaried VP of real estate to a contract position, and throwing themselves into the task of matching choice commercial real estate with choice franchisees.

Meanwhile, Wetzel and Phelps used their investors' contacts to nail prime leases in airports, malls, casinos, and sports arenas—most notably the brand-new Staples Center in Los Angeles. "I love going to the Staples Center for a ball game and seeing that line 20 people deep," Davis crows.

By early 1998 the combination of discipline and hustle began to pay off. Losses finally fell into line with the business plan, and in 1999 cash flow turned positive. The angels' million-dollar investment had sent the company sprinting. (It ranked #235 on the 2000 Inc. 500.) The chain expanded to 170 locations in 23 states and three other countries. Revenues exceeded $3 million in 1999, reflecting a gain of 1,063% since 1995, the year before Davis first sank his teeth into a Wetzel's Pretzel. And 2000 is looking sweet, with same-store sales up 13%. The partners expect corporate revenues to hit $4.5 million this year as total franchise sales top $30 million. And best of all, profits have almost tripled as the franchisor's overhead costs have been spread out over more stores. For the first time, Wetzel's has money—more than $1 million—just sitting in the bank. "John Davis just pushed the fast-forward button," says Wetzel.

Then there's the business's valuation which is, in Variety-speak, "boffo." "The company is worth six to seven times what it was worth when I invested," Davis says. "I'd submit that it's worth between $15 million and $22 million, based on the amount of cash flow produced together with cash in the bank. Everybody's goal is to drive the valuation to $40 million. I think that's possible in the next two and a half years." Davis is thrilled with the way Wetzel's has added to his already considerable fortune. "I was already a billionaire, but they made me a millionaire," he jokes.

Wetzel and Phelps, meanwhile, are sizing up several ambitious options for spending the cash they have. Should they add hard pretzels and pretzel sticks to their repertoire? Should they manufacture refrigerated products for supermarkets? Should they acquire another franchise and roll it out just as they've rolled out Wetzel's? The last possibility is particularly tantalizing to the founders, although they haven't seen another fast-food brand that appeals to them. Wilson, ever the numbers guy, thinks Wetzel's should focus on its market-tested product rather than branch out. "My strong preference is that we continue to do what we do well, well," he says. "We've got a great brand that's well known in southern California, but we're still not in a lot of places around the country."

The investor group is even warier of taking the company public. "Why would we want to dilute ourselves when we don't need any more investment?" Davis asks.

For Davis, the pretzel business has been a welcome complement to the one that serves popcorn. With three films in production last summer, he still found plenty of time to meet with Wetzel and Phelps. "When I produce a movie, I only like to do the artistic stuff like working on the script and casting the actors," Davis says. "When I do investments, I like to be really involved with the business."

Celebrity fans of the pretzels include Phil Jackson, Dyan Cannon, and Kim Basinger.

Another difference between pretzel making and moviemaking is that for the latter, large groups of people come together for short periods of time and then disband. With Wetzel's, Davis says, he enjoys the "kinship" of a company that has only 16 unchanging shareholders. "We've all now been together for three years," the producer says. "Usually, you get in a deal, and then there's a second round and then a third and a fourth, and maybe you sell out. Or there's a huge group of investors, and you're pulled away from the action. I love the intimacy of this. It's been a blast."

It's been a blast for Wetzel and Phelps as well. Although feigning nonchalance, they clearly get a charge when their investor drops an exasperated comment about Cher over lunch at Spago. And they concede that they were pleased when Davis invited them to a posh Bill Bradley fund-raiser at his Bel Air home. Now Davis and Phelps are trying to buy a luxury box at the Staples Center so they can watch Lakers games within arm's reach of a wet bar. Did they mention that they know Phil Jackson? The Lakers coach just loves Wetzel's Pretzels. He sent the pair a letter thanking them for furnishing his squad with free snacks during last year's NBA finals; it hangs, in a frame, on a wall in the company's lobby. They've also received fan mail from Dyan Cannon. Oh, and Kim Basinger was recently spotted in one of the Wetzel's stores. "The celebrity following of Wetzel's Pretzels is probably the greatest celebrity following of any snack food in the world," Davis gushes.

That dusting of glamour is one of the advantages the founders gained by choosing Hollywood money—and it was a choice. Wetzel and Phelps were already talking to a group of Orange County angels when Davis approached them; it was the producer's promise to play an active role in supporting the company that ultimately swayed them. But they also liked the fact that their investor was a player, and through him they're becoming players, too. For both the producer and the pretzel guys, this company may just be the beginning of a beautiful friendship.